Michael Doss - CEO, President and Director Stephen Scherger - CFO and SVP Alex Ovshey - VP, IR.

Ghansham Panjabi - Robert W. Baird & Co. Brian Maguire - Goldman Sachs Group Inc. George Staphos - Bank of America Merrill Lynch Adam Josephson - KeyBanc Capital Markets Inc.

Anthony Pettinari - Citigroup Mark Wilde - BMO Capital Markets Equity Research James Armstrong - Armstrong Investment Clyde Dillon - Vertical Research Partners Arun Viswanathan - RBC Capital Markets Gail Glazerman - Roe Equity Research Steven Chercover - D.A. Davidson & Co. Matthew Krueger - Robert W. Baird & Co..

Good morning. My name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the Graphic Packaging Second Quarter 2017 Earnings Call. [Operator Instructions]. Alex Ovshey, Vice President of Investor Relations, you may begin your conference..

Thanks, Kim. Good morning, and welcome to Graphic Packaging Holding Company Second Quarter 2017 Earnings Call. Commenting on the results this morning are Mike Doss, the company's President and CEO; and Steve Scherger, Senior Vice President and CFO.

To help you follow along with today's call, we have provided a slide presentation, which can be accessed by clicking on the Webcast and Presentations link on the Investors section of our website at www.graphicpkg.com.

I would like to remind everyone that statements of our expectations, plans, estimates and beliefs regarding future performance and events constitute forward-looking statements.

Such statements are based on currently available information and are subject to various risks and uncertainties that could cause actual results to differ materially from the company's present expectations. Information regarding these risks and uncertainties is contained in the company's periodic filings with the Securities and Exchange Commission.

Undue reliance should not be placed on forward-looking statements as such statements speak only as of the date on which they are made and the company undertakes no obligation to update such statements, except as required by law. Mike, I'll turn it over to you..

Thank you, Alex. Good morning, and thank you for joining us to discuss our second quarter 2017 results. Our second quarter adjusted EBITDA met our expectations at $171 million compared to $195 million in the prior year period. Net sales were down 0.8%.

The benefits of an acquisition and slightly positive core volumes were more than offset by lower pricing and FX, primarily pound sterling. The quarter was negatively impacted by accelerated commodity input costs, primarily recycled fiber, and planned maintenance downtime costs.

We completed our biannual maintenance cold outage at the West Monroe, Louisiana mill on time and on budget. We are executing on our announced price increases to offset the sharp recycled fiber input cost inflation and expect margins to improve from our pricing actions during the second half 2017 and in 2018.

We continue to expect our pricing to commodity input cost relationship to be at least $40 million positive in 2018. Our focus on meeting our cash flow commitments, growing cash flow and returning more of it to shareholders over time has not changed. We also continue to make progress on our key strategic capital allocation priorities.

Let me first provide a high-level update to our 2017 financial guidance. We expect our full year 2017 adjusted EBITDA will be in the $715 million to $735 million range compared to the previously provided $725 million to $745 million range.

The modest reduction reflects the re-acceleration of recycled fiber costs in June, July, as well as less realization from our announced CUK and CRB price increases. In July, the U.S. national average or OCC price was $167 per ton, up 74% year-over-year and above the $152 per ton price in April reflected in our previous guidance.

We are also modestly lowering our 2017 free cash flow outlook. We expect our 2017 free cash flow to be in the $370 million to $390 million range, down $10 million compared to our previous outlook. Let me now discuss the CRB and CUK price developments that have occurred since the beginning of the year.

As we have previously mentioned, we successfully implemented the first $50 per ton open market CRB price increase in the first quarter. The increase will be a slight offset in 2017 to the negative impact from the higher recycled fiber costs.

However, given the lag between changes in open market paperboard prices and our folding carton prices, we expect to see the majority of the benefit from the first CRB price increase in the first quarter of 2018. Since our first quarter call, RISI recognized $30 per ton of the announced $50 per ton open market CUK price increase.

RISI did not recognize the second $50 per ton open market CRB price increase. In June, we announced a new $50 per ton open market increase -- CRB price increase that we are -- we began implementing in mid-July. Looking ahead, we remain confident that we will see significant positive benefit from these pricing actions in 2018.

We also expect our cost models to benefit folding carton pricing in the second half of 2017 and in 2018. As we have stated in the past, we remain confident that our pricing initiatives will offset commodity inflation over time. Let me now provide more detail on the key operational trends we experienced during the second quarter.

Core organic volume in our global paperboard packaging business was slightly positive in the second quarter. As a reminder, our core volumes were flat in the first quarter and in 2016. We were encouraged to see these slightly positive core volume trends in the quarter.

We continue to plan for flat core volume in the second half of 2017, consistent with our volume trends over the last 18 months. We continued to outperform the end market trends reported by ACNielsen, driven by ongoing success of our new product development pipeline.

As we have discussed in the past, we expect our new product development effort to deliver about 100 basis points organic volume growth per annum. Let me highlight one important new commercialization in the quarter. In the quick-service restaurant market, we continued to gain traction with our SUS paperboard offerings.

We've launched a unique clamshell design carton, which holds the food item along with dipping sauces. The new container is made of our SUS paperboard and features a brown natural kraft look on the outside with a grease-resisting clay coating on the inside.

We expect the carton will add 3,000 tons of SUS demand into our mill system on an annualized basis, and we start the production in the second quarter. The global beverage market remained relatively healthy in the second quarter. The U.S.

beverage market continued to be led by growth in specialty drinks, including self-serve bottled water and craft beer. Our global beverage volume was up low single digits in the quarter. Shifting to performance. Our backlogs remained stable at 5 weeks for CUK and over 4 weeks for CRB.

As a reminder, our mill operations are highly integrated with our converting platform as we consume over 85% of the paperboard we produce. The business operated well in the quarter with a continued emphasis on improvement initiatives. Variable costs and operating efficiencies contributed to the majority of the cost savings in the quarter.

We generated $16 million of net performance in the second quarter. The $16 million includes a $14 million headwind related to our planned downtime cost for our biannual maintenance cold outage at West Monroe. Moving to cost.

Commodity input cost inflation continued to accelerate in the second quarter as we experienced higher costs for secondary fiber, logistics and chemicals. We absorbed $23 million of commodity input cost inflation in the second quarter. Published recycled fiber costs were up sharply in the period.

OCC prices averaged $149 per ton in the second quarter, up 75% year-over-year. I will now discuss our 3 strategic capital allocation priorities. Our first strategic priority is to reinvest in our business where we can generate compelling rates of return on capital projects across our mill and converting systems.

We expect to invest approximately $250 million in capital back into our business in 2017. As we've previously discussed, we invested $35 million to upgrade 2 headboxes on our #6 paper machine at West Monroe, Louisiana mill in the first quarter of 2017.

The project was well executed and has resulted in a higher quality paperboard sheet, which will drive significant cost savings at our downstream converting facilities.

We expect our overall capital investments will continue to deliver productivity benefits from the mid-to high end of our targeted $60 million to $80 million productivity range annually. Our second strategic priority is to execute on acquisitions at post-synergy multiples that are well below our trading multiple.

We announced the acquisition of Carton Craft in mid-June and the transaction closed on July 10. The Carton Craft transaction is highly consistent with our strategic objectives for acquisitions.

Carton Craft will allow us to integrate more of our CUK paperboard tons into a growing air filter frame market and will provide a runway for further margin improvement. We expect the deal to have a post-synergy multiple of less than 6x, well below our current trading multiple.

The M&A pipeline is solid, and we remain focused on continuing to find and execute acquisitions at compelling post-synergy multiples to enhance our geographic, customer and product profiles. Finally, our third strategic priority is to return excess capital to shareholders to drive long-term shareholder value.

We returned $43 million to shareholders in the second quarter of 2017 with $23 million in dividends and $20 million in share repurchases. We are confident in our cash flow profile and remain focused on returning cash to shareholders through dividends and share repurchases.

And with that, I'll turn the call over to Steve Scherger, our Chief Financial Officer.

Steve?.

Thanks, Mike, and good morning. We reported second quarter earnings per diluted share of $0.14, down compared to $0.24 in the second quarter. Second quarter results were impacted by a $6.1 million pretax or $4.4 million after-tax charge related to business combinations and other special charges.

For the remainder of my comments this morning, references to EBITDA and earnings per share will be to adjusted numbers. Focusing on second quarter net sales, revenue decreased by 0.8%, as a benefit from an acquisition and slightly positive core volume was more than offset by price and FX. Price was lower by $10 million, and the strong U.S.

dollar negatively impacted sales by $11 million. Second quarter EBITDA declined $25 million to $171 million. The decrease was driven by $23 million of input cost inflation and $10 million of lower pricing, which was partially offset by $16 million of productivity.

We ended the second quarter of 2017 with over $1.1 billion of global liquidity and $2.2 billion of net debt. Total net debt decreased $16 million during the quarter. Capital spending in the quarter was $68 million. We returned $43 million to shareholders via share repurchases and dividends.

At the end of the second quarter, our net leverage ratio was 3.1x adjusted EBITDA compared to 2.8x at the end of 2016. We remain committed to our long-term net leverage target of 2.5 to 3x. As Mike mentioned, we are executing a balanced approach to capital allocation, which includes returning excess capital to shareholders.

Since initiating the share repurchase program in the second quarter of 2015, we've allocated $291 million to acquire 22 million shares or approximately 7% of the fully diluted shares at inception. Turning to full year guidance. As Mike mentioned, we've updated our adjusted EBITDA guidance to a range of $715 million to $735 million.

This reflects the net impact of the re-acceleration in recycled fiber input costs and less realization from our announced CUK and CRB price increases. We've revised our 2017 cash flow outlook to the $370 million to $390 million range, to reflect the $10 million reduction in our EBITDA outlook.

We expect the 2017 pricing to commodity cost inflation relationship to be negative $80 million to $100 million. This compares to the previous negative $60 million to $90 million. The updated range reflects increase in recycled fiber prices in July and less realization from our announced CUK and CRB price increases.

We continue to expect the labor and benefits inflation to be $20 million to $25 million. On performance, we are well positioned to achieve at least the midpoint of our targeted $60 million to $80 million range. Shifting to volume. We expect core volume to be relatively flat consistent with recent trends.

We remain focused on outperforming the market through new product development, customer and geographic expansion, and substrate substitution, all consistent with prior years. We expect third quarter 2017 EBITDA will be in the $185 million to $195 million range.

We expect EBITDA to improve significantly during the second half of 2017, as commodity input cost comparisons ease, our pricing improves and productivity is strong to deliminate maintenance downtime. Lastly, I will briefly discuss our effective tax rate outlook. Our full year effective tax rate guidance of 35% to 37% remains unchanged.

However, we are likely to see a slight increase in our quarterly effective tax rate in the third quarter due primarily to timing. We project a range of 37% to 39% for the third quarter. The remainder of our guidance is contained in our last page of the presentation on our website. Thank you for your time this morning.

I'll now turn the call back to Mike..

Thanks, Steve. We remain confident in our business model and ability to execute with excellence in a complex operating environment. We're keenly focused on recovering commodity input cost inflation through pricing and expect to make significant progress during the second half of 2017 and in 2018.

We will plan for flat volume and have targeted initiatives in place to outperform the market through new product developments in substrate substitution consistent with prior years. And we will continue to be well positioned to generate productivity that is well in excess of our labor and fixed cost inflation.

Lastly, and importantly, we will continue to execute on our key strategic capital allocation priorities, specifically reinvesting in our business to drive strong cash returns and cash invested, executing and integrating strategic acquisitions at compelling post-synergy multiples, and returning cash to shareholders through dividends and share repurchases, all of which drive long-term shareholder value.

And now I'll turn the call back to the operator for questions..

[Operator Instructions]. Your first question comes from the line of Ghansham Panjabi..

Curious to get your longer-term view on the OCC market.

Do you believe these levels are sustainable and more secular in nature? And then separately, just given the amount of volatility you're seeing, which is kind of unprecedented, are you as well as the industry looking to short these lags as these contracts are up for renewal at the end of the year?.

Yes. It's Mike.

I guess, as we talked about on our second -- our first quarter call, excuse me, we expect more over the medium term an upward bias on OCC, consistent with the trends that we talked about, which is really the rise of secular containerboard capacity both here and in Europe and in China, as well as an upward trajectory on overall demand related to some of the e-commerce channels that have been well chronicled there as well.

So that's our view going forward. In terms of being able to compress that time line, which right now we average 9 months, we're always looking to do that as we go into negotiations and have that on the agenda as we start with those contract renewables here in the U.S. going forward.

As you know, it's competitive environment and that's something that takes time to do. But certainly, given the volatility that we've seen, our belief is that we will continue to make traction along those lines in the quarters and years ahead..

Okay.

And then I guess, bigger picture, why do you think you got less traction than you expected for the CUK and CRB increase? Particularly on the CUK side, just given the backlogs are pretty strong, was there just less support from the industry, weak demand? And then, what's changed? Obviously, OCC has moved up, but just curious on high-level on the pricing environment..

I think you said it. I mean really what happened in April and May on the CRB side is there was a reduction in OCC costs after a couple of pretty quick rapid-fire price increases. Having -- if you look at the time since then, 130,000 tons of capacity has come out. Operating rates are in the mid-90s. Inventories have started to come down.

As you recall, we talked about the fact that our experience post the mill closure, that usually takes a couple of quarters for that inventory to work its way through the system, we believe that's the case. And in June and July, we saw an increase in OCC again and at least for Graphic.

That made sense for us to go out and announce another price increase, which is exactly what we've done, and we're in the process of implementing it..

Are you seeing any changes in the behavior from your competitors for this increase versus the last one? I mean, obviously, costs have gone up dramatically..

I think they face the same macroeconomic backdrop that I just described. I mean this is not marginal increases on secondary fiber. It's up 75% year-on-year. It's hyperinflationary. And as you know, that's the key input into coated recycled paperboard on a variable cost basis. So it's critical. We go get it. And that's where Graphic is focused on..

Your next question comes from the line of Brian Maguire from Goldman Sachs..

Just a question on -- following up on those questions around the lack of traction on the price increase and it sounds like the $40 million price versus cost in '18 includes getting a fair amount, if not all, of the $50 increase you're proposing for July.

Just wondering the sensitivities if you weren't able to get that for whatever reason, how that would kind of impact the outlook into '18? And this is, again, a theoretical exercise, but if you didn't get that, do you think we would expect or do you think the industry would need to take some more CRB capacity out, if we were going to see continued or higher OCC prices without getting any push through on the CRB?.

Brian, this is Steve. Let me focus first on the $40 million 2018 part of the question and then Mike can take some -- the rest of it. But just in terms of what you articulated, the $40 million price cost for next year is comprised, as you were referencing, of the $50 original CRB price increase that was recognized, $30 of SUS.

And then as Mike said, we're actively implementing the next $50 on the new CRB price increase. And we've assumed a fair amount that obviously in our projections along with the improvements you'll see in our cost model.

So that gives us confidence there's at least a $60 million to $70 million price improvement that we have line of sight to as we look out to 2018. On the cost side, as we've talked, we always assume OCC prices roughly where they are today. That's July, that's $167 on a national average.

If you assume that over the next 18 months, along with reasonable inflation assumptions for other important commodity costs; wood, chemicals, logistics, we see that in the $20 million to $30 million range. Again, this is all the way out to 2018.

But we've got good line of sight today based upon what we know and with reasonable assumptions going forward kind of $60 million to $70 million on price, $20 million to $30 million on cost, giving us confidence in the $40 million plus.

If the next CRB price increase didn't occur, we would, obviously, take additional action given the hyperinflation that Mike was referencing a moment ago.

So Mike, you want to take that?.

Yes, I think, Brian -- I think, as you think about that for Graphic, we make roughly, if you think, out of 2.5 million tons of paperboard, close to 1.5 million tons of that's SUS, 1 million tons of that's CRB. And 85% of all that production is falling to our converting operations and sold in the form of packages.

So what we do every year is take a step back and take a look at what tons we're going to need to run our business with. And we want to run the tons that we're going to -- that our customers need at the lowest possible cost.

And so in recent years given some of the acquisitions we've done, both in Europe and most recently here with Carton Craft, we've made some pretty significant investments back into our SUS system, in particular, West Monroe, to unlock some of that pulp that we've talked about and create some additional tons that allows us to serve us that business.

On the CRB side, the focus has been less on tons and more on lower cost tons, taking structural fixed costs out, given that market. And so that's our approach. And to answer your question around kind of go-forward, that's what we're going to continue to do as we look at kind of the macro environment, what our customers need for us to do.

And we do that each and every year to make sure, again, that our supply is matched up with our customers' demand..

Okay, appreciate that. Just switch gears and more of a high-level question here. There are lot of different trends going on out there in packaged food. One of them seems to be an increased shift towards the private label and some of the potential acquisitions out there in the space. Maybe you're going to accelerate that.

Just wondering as you kind of look at the landscape changing, do think you guys have the right product offering and is the sales force sort of aligned properly to kind of go where that growth is moving to in the industry?.

Yes. It's a great question. That is a trend we continue to see, and we expect that trend to continue to grow. Private label or store brand or convenience in the case of our business in Europe, that's a big part of our business already. We've made strategic investments to get knowledgable and to have the capabilities to be able to service that market.

So, yes, we're positioned to be able to service it now and grow it into the future and that will be our plan..

Your next question comes from the line of George Staphos from Bank of America..

I wanted to come back to the discussion on CRB and, I guess, lowering the cost position. Mike, would we expect -- let's assume that pricing doesn't develop as you expect. Obviously, that's plan A. But, let's say we're instead working with plan B.

Does the ultimate reduction on the cost curve that you would then look to implement in CRB take the form more in terms of trying to find lower-cost sources of fiber? Does it take more investment in the mill system to lower the cost? Does it suggest more chopping the tail off of your production? I know it's difficult to get into too much granularity there, but would appreciate your thoughts.

And then the follow-on question I had, separate question. When we reverse-engineer your free cash flow guidance relative to your EBITDA guidance, we wind up requiring working capital being somewhere in the range of $30 million, $40 million as a positive.

Could you correct or affirm that and tell us what's driving your working capital usage?.

Thanks, George. Yes, I'll handle first part of your question, and then I'll hand it over to Steve for your question regarding working capital. But in regards to your first point around kind of shifts in fiber and costs.

Yes, as I just explained, I mean we're going to take a step back each year with both the near-term and medium term in mind relative to what we see our fiber costs been. And in the case of SUS, if we believe that we can actually move more product into SUS and that's what our customers want us to do.

We will continue to move in that direction and that might take the form of some of our current CRB. If OCC prices continue to go up, the trade over between virgin and recycled actually is pretty solid. So we'll look at that. We don't want to do that in a particular singular point in time. It's got to be done over, like I said, a medium-term horizon.

But it's certainly something that's on our minds, and we'll continue to evaluate that for an opportunity. We have 2 very low-cost CUK mills, one in Macon, one in West Monroe. They're well capitalized. We continue to invest behind them in a very low-cost mill on the CRB side in Kalamazoo.

So those are our assets and the ones you could expect that will continue to look to drive our costs down in a pretty complex macro environment..

And, George, it's Steve. On working capital, your assumption is correct. As we've talked about before, we've got very strong initiatives focused on improving our overall working capital. We're having the success with them. That $30 million to $40 million is an appropriate target relative to the impact -- positive impact on cash flow this year.

It will come from improvements that we've -- that were captured primarily on the accounts payable side of working capital. We've been holding our inventories in good position. We do have, of course, some inflation rolling through inventory valuations given the inflation that we're seeing on recycled fiber costs.

But we've been able to offset that with other initiatives that we have underway focused on, as we've talked before, SKU rationalization, good strong initiatives on inventory reduction across our integrated systems. So those have played heavily to a draw, and we've seen good improvement in other aspects of working capital, primarily payables..

Steve, you touched on it, and if I can just tag on here and then I'll turn it over. You mentioned you're doing some other initiatives in the face of higher OCC. Clearly, costs, recovered fiber prices went up sharply in the quarter versus 1Q.

Can you give us a case study or for instance or some number on the additional measures that are driving the working capital?.

Sure. I'll give you just an example on the inventory side. On the paperboard mill side, we have initiatives underway where we're actually decreasing the number of internally SKUs, the number of internal variety of roll width that we use internally.

They grew over time kind of naturally, and we've actually gone back in and said we can actually drive internal paperboard volumes of inventory down by rationalizing those SKUs.

There's very minor trade-off on waste that we've been able to then recapture back into our system and it's been a net positive for us on -- from a cash flow perspective, as a good example of the kind of initiative we have underway, focusing on, as Mike was referencing earlier, this very large integrated system we have and our ability to take cost out of the middle of it as we service the supply chain..

Your next question comes from the line of Adam Josephson from KeyBanc..

Steve, just one for you on cash flow.

Can you just remind us of the NOL situation for next year and how much your cash taxes will be up next year as a result? And also, along those lines, what do you expect further working capital benefits in '18, in $30 million, $40 million range?.

Yes, Adam, I'll touch on those individually. Our NOLs remain in a good place. We won't be a U.S. cash taxpayer of substance in 2018. We would expect to begin to turn that corner out into 2019. So no change there. And as such, our cash taxes for next year might move up modestly, but it'll move up in low millions of dollars from what we're seeing this year.

Wouldn't want to provide specifics on working capital for next year. But as we mentioned, we've got good strong initiatives in place. We certainly wouldn't expect it to be a significant use of cash flow. Wouldn't want to pinpoint a range at this time. But it's important to us.

We're very focused in on it, and we certainly see it as a potential source of cash, but wouldn't want to put a -- peg a number on that quite yet relative to 2018. But the NOL is in good shape all the way through, cash taxes modestly -- very modestly up..

Okay, Steve. And just one for either if you. Just on the price cost guidance for next year. So based on your guidance, obviously, your organic EBITDA is going to be down this year as it was last year. We all know about demand for CRB and the failure of the most recent price increase that happened, historically inflationary OCC costs.

So I guess, given these unknowns and this unprecedented OCC inflation and obviously, you and others didn't see coming, why guide to any price cost benefit next year and just say, "We don't know. Visibility is limited. And well, we'll take it as we see it?".

Well, that's an interesting question. I think we would have quite an interesting response if we said, "Well, we just don't know." I think what you're hearing from is we're going to control those things that we can control.

And over time, when we see inflation like this on the raw material, we'll manage it in ways that, of course, have to cover price consistent with that commodity inflation over time. That's a long-standing commitment of ours as a corporation.

It's how we've run our model for decade in terms of price offsetting, commodity inflation over time and that's a commitment we're not moving off of. And as Mike said, well, earlier, we do that, of course, in looking at our own overall supply-demand dynamic internally. Because over time, the pricing needs to offset commodity inflation, deflation.

This is unprecedented, but it can't really alter our commitment to the price commodity cost relationship over time..

Adam, it's Mike. I'd love to be able to do what you just described and the question's a good one. It just -- as Steve mentioned, the last really 12 months have been kind of exceptional with CRB prices moving down $70 a ton and then OCC prices moving up 75% year-on-year. So it really was a true price cost squeeze. It's been well chronicled.

And what we felt we need to be able to do is to give some visibility through that process, how our business model's working with the assumptions that we're using to the best knowledge that we have..

Your next question comes from the line of Anthony Pettinari from Citi..

Mike, you talked about moving to an automatic pass-through model for folding cartons. And I think you've talked about moving from maybe 50% to 70%.

Is there a time line for when that 70% might be achievable? And given OCC is on this upward trend, do those discussions with customers become significantly tougher than they were, maybe last year? Any kind of thoughts you had on that..

So our target, Anthony, that we put out there was we were targeting 70% of our pricing, if you will, to be on cost model basis and moving away from pure market model basis. Look, in a mature market, like the one that we operate in, all pricing discussions with customers are difficult. So it really hasn't changed in that regard.

I think the real piece of it that we continue to work on with our customers is, really being able to try to smooth out some of those peaks and valleys from things going up $50 a ton down $50 a ton and more tied to the actual input cost inflation that we generate, which this year is unprecedented, but in most years is pretty balanced.

And so over the last, really, 5 years, we've seen good traction along those lines. As you recall, in 2008, we had 0 of our contracts that were on this and since that period of time, we've been able to work that number up to 50%. And we remain confident. We'll get traction towards our 70% goal, and we'll keep you posted on that..

Okay. That's helpful. And then just following up on your comment on OCC having a medium-term upward bias. To put a finer point on that, do you expect OCC to be up in August? Any sense of how much? And then, China has indicated it will ban unsorted paper imports by year-end.

And it seems like there's a lot of confusion as to whether unsorted paper includes all grades of mixed paper. So I was just wondering if you -- as you talk with your suppliers, if you have any thoughts on how they gauge the impact of that announcement.

Is this maybe another leg up for OCC? Or is China just kind of confirming something that they've been doing already for most of the year?.

Sure. If you really think about the unsorted ban, if you will, that was announced, I think, July 18, it's really going to come down in China how that is implemented. I mean, as you know, Anthony, they run the largest recycled containerboard system in the world.

And so if they ban unsorted mixed paper, I think the data we see is that's roughly 5.7 million tons that they import and 2.4 million of those tons come from the U.S. That could have an impact on OCC for sure. We don't have a recycling division.

So as we've talked about this in the past with you, we use our current OCC price to do our projections on, which is consistent with what we did for the latter half of this year and into 2018, as Steve has suggested in his comments.

We did see that one -- another paper company with a large recycling division announced last week, they thought it could be up $10 a ton in August. I guess time will tell. We don't take a view on that just given we're not actively in that market..

Your next question comes from the line of Mark Wilde from BMO..

I've got a couple of questions, Mike, but I've also got just the general comment. I've been watching this industry for a long time. This is not an unprecedented spike in OCC. We saw OCC over $200 almost 25 years ago.

So it seems like what you do have right now is you've got this sort of mismatch between kind of what's happened to CRB prices and what's happened to wastepaper. But if we look over time, it seems to me whenever the global containerboard market picks up, we have volatility in OCC.

And when things drop off, like they did back in '08, '09, OCC falls through the floor..

I'd argue that, Mark?.

Okay. All right. I mean, I just -- I look at that price we had back in the mid-90s, Mike. If you inflation-adjust that, that's probably the equivalent of like a $350 or $400 a ton OCC price today, in inflation-adjusted terms. So I don't think any of us know where this is going. But the history of volatility on OCC is a pretty long one.

So with that aside, just a couple of other questions.

Where are we, going back to Anthony's question, in terms of the amount of carton business right now that is on the pass through? Is it 50% or has it moved up?.

It's about 50%, Mark..

Okay. And then can you just -- switching gears a little bit, can you talk about sort of what the M&A priorities might be? In the past, you've talked about growing the platform over Europe. You've also talked over time about sort of growing the food service business.

And I think you've been doing some interesting things, as you highlighted just organically in food service.

So where are the priorities and how high would you be willing to take leverage?.

So our priorities, as we talked about in the past year, are really focused on North America and in Europe. We have been opportunistic, as you know, in some other markets. But our clear focus is in North America and in Europe. We made the acquisition with Carton Craft here in the most recent quarter. We just closed that here on July 10.

That's a great example, Mark, of CUK-type product into a market that actually is growing somewhat as opposed to some of our other verticals in the food and beverage space. So I think -- I point to that. I'd also talked a little bit, as you've articulated, around food service and the perimeter to the store continuing to gain traction.

And we've been fairly successful on being able to deploy our CUK into those kind of applications..

Okay.

Then the last question I had was actually just if you could give us any sense of overall kind of folding carton volumes, Mike, in the -- for the overall industry? Because that data often doesn't find its way out in the public domain, so none of us are -- have a real good grasp on how much the overall carton market is growing or shrinking?.

Mark, the best knowledge information we have to do that would be the AF&PA data. And what that would suggest is that bleach paperboard through June was up 0.2% of 1% -- or, excuse me, unbleached CUK is up 0.2% of 1%. Solid bleach is flat really led by food service and cup and plate. And CRB is down about 0.6% of 1% through the month of June.

That's how we would look at it..

Your next question comes from the line of James Armstrong from Armstrong Investment..

The first question, just going back to OCC for a moment.

Could you remind us about how much of your input fiber is OCC-based? And what are you expecting for OCC in your guidance?.

So I'll handle the first part of that. James, we buy about 1.2 million tons of secondary fiber of which about half of that is OCC and double-line kraft and the rest would be other grades..

And, James, our guidance assumes the July pricing. So the national average of $167 is what's in our guidance..

Perfect. That works. And then moving on to bigger picture.

As e-commerce grows and starts touching packaged foods, how is GPK adjusting to the shift to e-commerce? More importantly, how are your customers shifting to the -- to e-commerce?.

Yes. So I think a lot of people are trying to figure out exactly what that means for them, particularly our customers. We're working with them on a number of created -- creative solutions.

Our new product development group is actually actively engaged with e-commerce suppliers and home delivery food service options that are there, using our CUK paperboard. That's got great branding characteristics and capabilities and in some cases, can be used in a channel -- an e-commerce channel without requiring a corrugated box..

Your next question comes from the line of Chip Dillon from Vertical Research..

First question, just -- I know I probably have asked this in the past, but you talked about the price cost spread next year and you mentioned the cost part of that would be, I think, up $20 million to $30 million. Now that does not include labor and benefits. That's on top of that.

Is that right?.

That's correct, Chip. And just for clarity there, that plus $40 million is price versus commodity input costs. And so wood, OCC, chemicals, logistics, et cetera.

As we've talked in the past, our ongoing productivity initiatives roughly the $60 million to $80 million a year that we'll pursue year in and year out would more than offset our $20 million to $30 million of labor and benefits inflation.

And that's an additional, if you will, roughly $40 million of improvement that we stay very committed to on a year-over-year basis. So, yes, to your question, labor and benefits are not included in that $20 million to $30 million. As you know, we focus that -- our productivity initiatives heavily on more than offsetting labor and benefits inflation..

Got you. And to be just clear, the guidance on the pricing part for next year, that includes getting all of the CRB June increase that you announced.

Is that right?.

Gave you kind of a range on it at $60 million to $70 million. So I think you can assume it's the majority of it..

Okay. And then on the EBITDA guidance, it looks like if you kind of midpoint everything, you're looking at something around $204 million for the fourth quarter. And if that's true, then there might be seasonal issues. I think, if anything, that's not one of your best seasons.

I mean that kind of gets you keyed up for north of $8 million, $10 million, let's say, next year and then you add the $40 million from the price cost that could get you up in the mid-800s, if I'm not missing something.

Now offsetting that, of course, would be, I guess, the $15 million to $20 million -- I'm sorry, the $20 million to $25 million in labor. So that might push you back down into the $20 million, $25 million range.

But so far, have I anything that doesn't seem right?.

Well let me just focus on your Q3 to Q4 for a moment, because I think that's the most relevant part as you were touching on, Chip. It's kind of the midpoint on Q3, the $190 million range. We do have one significant last normal downtime in Q3 in our Macon facility. That won't repeat in Q4.

And we have a little bit -- as you were referencing, a little bit of a unique phenomenon and that is we roll into Q4 based upon our mill activities. We'll have limited downtime Q3 to Q4. We'll start to turn the corner on the price cost.

And I think that's the primary driver as we start to get -- see our margins enhanced by the -- some of the pull-through that begins in Q4 in earnest as we then roll into next year..

Okay. And then I guess last question is on the interest line, sort of a small item. But it looks like it's kicked up a bit and if I keep it at sort of that $22.5 million rate more or less, I would be in the high 80s as opposed to the upper half of what you're guiding to.

And is that a good number to kind of use going forward per quarter? Or is that a reason it popped up this quarter?.

Yes. No, it's -- you're seeing it as roughly right. It might be near the higher end of the range based upon what we're seeing currently in terms of debt balances and interest rates..

Okay. And then the last one is I noticed on the volume that you were actually up year-over-year on that -- on your tons and the revenues were down a little less than 1%. So kind of on a per ton, and I know that there is a lot of moving parts, but it was down more than 2%.

And if you step back and think about that, is it mostly mix? Could it be a mix of converting versus open market? Or was it a lag in price -- getting the pricing? Because I know perhaps there might have even been some lower prices in the second quarter this year versus last year because of the lags you have. I don't know if that played into it..

Yes, that's right, Chip. It's Mike. I mean it's really that $70 a ton kind of flowing through the market side of the tons on the CRB. They are impacting pricing at the same time you've got secondary fiber costs going up..

And also, Chip, you've got FX in there as well, when you're -- I think if you're looking at it the way you were just looking at it on a per-ton basis..

Right, right. And that's $13, I think you said, million. I got you. All right. That's very helpful..

Your next question comes from the line of Arun Viswanathan from RBC Capital Markets..

Just had a question along the lines of OCC again.

Is there anything you can do, and I know it's not overnight, but to shift your strategy towards using less OCC in your system? And then given that you don't have recycled operations right now in-house, would it be beneficial to look into maybe potentially acquiring those operations or building those?.

Arun, it's Mike. I mean I think -- as we think about secondary fiber back into our operations, that percentage of OCC is actually -- if you compare that against containerboard, actually less in many cases we're using. Meaning, we're using less OCC and double-lined kraft and using most box cuts and another types of lower-cost fiber to actually do it.

Those are projects we continue to look at all the time, and we'll continue to do so, given our view over the medium term, as we talked about, that we see more of an upper bias on secondary fiber costs. So the answer to that would be, yes, we're looking at that.

In terms of secondary collection -- fiber collection operations, sure, we would look at things like that if they presented an opportunity. But it tends to be more of a hedge as opposed to a material change in your ability to drive cost down. We get some marketing intelligence and things like that, that is there.

But at least as we started up to this point, it won't have a material impact on our overall cost structure..

Great.

And as a follow-up, is there anything you can do, I mean -- and would it be necessary to potentially consider increasing your productivity targets on an annual basis if you are now thinking that OCC is at a newer higher level?.

Well, I think there's a couple of things as we look at our mill systems around structural cost, and we gave you an example of one we did last year. That curtain coater where we spent $30 million and took out $10 million of structural cost, we still have 3 more paper machines to do along those lines.

And, as you know, that eliminates -- the largest component of that is TiO2, which has gone up in price this year and is forecasted likely to continue to increase in the outlying year. So we're looking at those.

And again, if we found projects that we felt had cash-on-cash returns that allowed us to substitute one type of fiber for another, we would actively pursue those as well as part of our CapEx guidance that we provided..

And just lastly, similar question on the volume side.

Maybe you can give us an understanding of how much of your volume you think is specialized or potentially has ability to grow above the rest of your portfolio, whether it's in beverage or e-commerce or anything like that? And are there opportunities to grow that portion either organically or inorganically?.

Yes. I'd point to our NPD process there. It's something that's consistently over the last five years, for sure, delivered 100 basis points of year-over-year sales improvement. It tends to be on a number of platforms, strength, microwave, food service.

Those types of parts of our business that are actively growing, or we believe there is an unfulfilled need that our CUK or CRB could represent an opportunity. So that's where we spend our time and place our resources..

Your next question comes from the line of Gail Glazerman of Roe Equity Research..

Maybe just quickly following up on Arun's question on kind of alternative waste.

So if China is serious and does restrict mixed waste and some of that 2.5 million tons backs up into the U.S., is there anything that you can do specifically to kind of incorporate more mixed waste into your production? And if so, how long would that take?.

Yes, Gail, it's Mike. We use some of it now. But again, one of the things we got to make sure is that our product performance characteristics on our CRB sheet actually meet the expectations. So we look at those kind of projects.

I think more likely what you'd see us doing is making some investments that will allow us to use more of our own CUK clippings back into our operations where we use some of them now, but we do export some of them as well. So that might be an area that we would choose to place some emphasis as well..

Okay. And I'm looking if you could give some perspective on how you're thinking about the bleach board market these days, I guess, in terms of acquisition priorities with OCC moving as it become more of a priority interest for you, and just generally maybe the European FBB and the acceptance rate in the U.S. market..

Sure. Let's take care of the European acceptance rate in the market and what -- at least what the data is that we have up to this point. It would appear that imports, at least from Sweden, are up about 37,000 tons so far this year, while at the same time, imports from China, Canada and Finland are actually down a little bit.

So it appears that, that is playing out as we've talked about in the past. They're gaining some traction along those lines, although on a 5 million ton base that's not a huge number. In terms of how we think about SBS, again, we're one of the largest purchasers of SBS, as you know, Gail.

And food service around the perimeter of the store has been growing, and you see it in the SBS numbers. It's actually -- depending on the vertical, it's at least flat. And some of those are actually up to include food service and cup and plate.

And so like any other opportunity that would present itself, we look at it and if we felt that we could have an investment that would generate a return in excess of our current trading multiple at post-synergies, we'd evaluate it. Having said that, as we've stated in the past, it's not a strategic imperative that we have to do it..

It'd have to have a path towards integration..

Right..

Okay.

Would you be willing to accept something significantly below your 85% of waste initially, if you have that line of sight?.

Yes, as long as we have line of sight and a point of view that over time, over the medium term, we could increase that integration percentage. And again, our track record, we've been able to do that on CRB and our CUK is very good..

Your next question comes from the line of Steven Chercover from Davidson..

First quick question, it's on volumes as well. Thanks to the 0.4% core volume growth in Q2. I think you're up just a snick year-to-date. So evidently you're expecting a slight decline in the second half.

Is that based on order files or conservatives?.

No, Steve. This is Steve. I think what we're saying is we're within 30, 40 basis points of flat. It's not a projection that has that level of precision. We're really just articulating that we continue to believe that through new product development that we can be at flat volumes that offset some of the markets that are in modest decline.

We're not seeing anything from an order rate or order pattern perspective that assumes a modest erosion in the second half. It's more just that we've been -- as we convey guidance around a full year, a full-year trend consistent with prior years are basically flat is what we've incorporated in..

And as a follow-up, in addition to the clamshells and maybe some of the e-commerce initiatives, can you help us understand what other opportunities might be in the new product pipeline?.

Yes, sure. I mean our strength platform is the one that I'd point to. We continue to win volume in that and that's really around disappearing pallets at the end of aisles. Our beverage business continues to grow on a global basis. That's also U.K. So we've got a number of these verticals that are actually doing quite well that use that paperboard..

Your next question comes from the line of Ghansham Panjabi from Robert Baird..

This is actually Matt Krueger sitting for Ghansham. How would you characterize the integration efforts for the Carton Craft acquisition? And then, what can we expect in terms of deal flow for the second half of 2017 and 2018 versus what we've seen over the past year? Even if it's just in general terms, that helps..

Yes, okay, Matt, I'll take a cut out and Steve can add some color. In terms of Carton Craft, we literally just closed that July 10. So it's early days in that process. We're making sure we understand customer needs and expectations.

There'll be some paperboard integration opportunities for us and probably some operational synergies will be able to generate as well.

We're excited to have them joining our team and believe, as we stated, that we'll be able to generate $3 million to $4 million worth of synergies over the next 12 to 18 months, which will take that multiple to be below our -- below -- sub-6. So good acquisition for us. And I think that's the point that I point to.

Deal flow, we're pretty cautious and thoughtful in terms of how we're looking at these acquisitions. We need to make sure we've a point of view that we can get at least 2 turns of synergy down and have them -- have cash-on-cash returns that are in the high teens for our shareholders.

And so, as I mentioned, we're looking at those in North America and in Europe predominantly. We have a number of irons in the fire. As we've talked about on previous calls, it takes some time to develop those relationships. In many cases, on some of these that we're working with are private companies and they've been around for a while.

And so we've to work through the cultural issues and talk about what integration would be like and how that all looks on the other side for those owners. So we're actively working on it and it's a key priority for us..

That's helpful.

And then can you break out the 2Q '17 volume performance by region for your various businesses based on Europe, Mexico and North America? And then, can you provide a brief outlook for each of these regions as well for 2017?.

I think we just speak broadly. We're seeing very consistent volume activities, almost region by region. We see some modest growth, as we've talked before, in regions like Mexico. We actually have seen modest growth in Europe just given some of the very good work that the team's doing there as we integrate additional paperboard. Overall, the core U.S.

volumes are pretty flattish, if you kind of stand back from it. That's consistent with our overall. So we've got pockets of growth regionally. We're seeing some growth with our Australia, New Zealand acquisition that we've completed there, as that -- as we integrate those businesses.

Asia, we're -- Japan is a little more of a challenged market, where China is a growing market. And those kind of play themselves out. So I wouldn't -- on a relative basis, I wouldn't characterize it as moving the needle because those businesses are smaller, they're growing businesses.

But in total, it plays to that flat volume trend that we've laid out for you..

Great. That's helpful. And then very quickly, it looks like you expect productivity to ramp relatively significantly in the second half of 2017.

Can you help us in terms of how we should layer that in third quarter versus fourth quarter?.

I think what you'll see is, as we mentioned, it's going to play itself out pretty positive both in Q3 and Q4, heavily driven by the fact that we have significantly less maintenance downtime, almost $30 million of less downtime in the second half versus the first half.

And overall, as Mike referenced, our operations are running well and effectively year-over-year. So it would, I think consistent with, that you play the guidance out, you'll see good strong productivity in both quarters, consistent with the mid-to-upper part of the $60 million to $80 million range..

I will now turn the call back over to Mr. Doss..

Thank you for joining us on our earnings call. We look forward to speaking with you again in October. Have a great day..

This concludes today's conference call. You may now disconnect..